Emerging markets review: Differentiation but few surprises

Emerging markets in 2017 were marked by relatively fewer surprises compared with recent years. The global upturn in trade and production lifted growth beyond last year’s expectations, but emerging markets were largely in line with the broader, global upturn.

Growth continued to improve from the trough of 2015 and emerging markets assets posted their best year since 2010 — the MSCI emerging markets equity index is up over 30 percent year-to-date; dollar-denominated bonds have gained 9 percent; the emerging markets local-currency debt index has risen 13 percent; and most major emerging markets currencies have posted gains against the dollar – but, again, the gains have largely not been about emerging markets specifically.

The global recovery has supported sentiment and risk flows which also boosted developed market equity and bond indices, and currencies. While little in the emerging markets growth performance stood out significantly from the broader global economy, it’s worth considering what factors allowed emerging markets to recover strongly in line with the global economy. This is particularly pertinent since not so long ago many analysts and strategists were predicting the demise of the emerging markets growth model, declaring it either too reliant on commodities or too reliant on stagnating global trade.

Looking at the trends that shaped this past year, perhaps the most impactful event of the year was China’s 19th Party Congress. While not impactful in its own right (at least not in the near term), the anchoring of the party congress and creation of a widely held belief that the Chinese government would make every effort to ensure stability – economic, financial and social – leading up to the congress, largely removed the “China risk” from the minds of investors and helped boost emerging markets sentiment and flows.

Last year’s policy mix of credit/fiscal stimulus combined with supply-side constraints effectively eliminated the threat of deflation and lifted China’s all-important housing sector (see chart). This combined with the correct assumption that China would maintain a stable currency, marginally reduce financial sector risks and support household consumption allowed a “China stability” narrative to take hold and improve sentiment towards broader emerging markets. It was largely expected that this would be China’s 2017 goal; however, the extent to which policymakers were able to carry it out was nonetheless surprising.

Emerging markets growth largely came in above our forecasts, with China, Brazil, and Russia surprising on the upside. However, going back to the end of 2016, most economists, including ourselves, would have been surprised to know that India was one of the largest downside surprises.

In a year that saw forecast upgrades across most emerging markets, and synchronised global growth, Indian growth came in surprisingly below initial expectations. Some of this was expected from the lingering effects of demonetisation; but, while the newly implemented goods and services tax was widely heralded as a boost to efficiency and growth, short-term disruptions were not widely anticipated.

India’s weakness also broadly reflects the trends that drove emerging markets over this past year. Judging by which countries saw upgrades versus downgrades, the two main drivers were commodities (and China) and the tech cycle. Those countries that were able to take advantage of higher commodity prices or increased tech component demand saw growth surprises. Those who couldn’t, like India or Mexico, were left out of the rally.

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